This article first appeared in Capital, The Edge Malaysia Weekly on November 14, 2022 - November 20, 2022
AFTER two years of a superbull run, Bursa Malaysia-listed semiconductor and semiconductor-related companies have seen their market capitalisation crumble since the beginning of the year, much like their counterparts in the US and other parts of the world.
On average, share prices of The Big Four outsourced semiconductor assembly and test (OSAT) players — Inari Amertron Bhd, Malaysian Pacific Industries Bhd, Unisem (M) Bhd and Globetronics Technology Bhd — as well as the Big Four automated test equipment (ATE) manufacturers — ViTrox Corp Bhd, Pentamaster Corp Bhd, Mi Technovation Bhd and Greatech Technology Bhd — had declined a significant 40% year to date (YTD) and 5% over the past one month.
Their weak stock price performance this year has been attributed to growing concerns over slowing chip demand, fears of a recession and weaker consumer spending amid soaring inflation, exacerbated by the ongoing US-China trade war, which prompted the US to impose semiconductor export restrictions against China.
After reaching a peak in orders two years ago, the semiconductor industry appears to be in a trough. The Malaysia Semiconductor Industry Association (MSIA) anticipates growth to continue at 8% to 10% in 2022, following an astonishing 26% growth in 2021.
But it anticipates a weaker 2023, as demand in consumer-centric end markets, such as personal computers and smartphones, is poor, although this is partly offset by the automobile industry, which continues to be resilient, thanks to a high bill-to-book ratio.
So, is the worst over or is the worst yet to come for the tech sector? More importantly, what should investors do?
Normalisation in stock price and valuation
Tradeview Capital Sdn Bhd CEO Ng Zhu Hann says that in the battle over semiconductor and chips supremacy among developed nations, Malaysia is blessed, as it is in a unique position and can play a key role in a very important industry.
“We are part of the global supply chain with estimates putting our country’s semiconductor industry as contributing 7% of global market share. This contributed to the exponential growth of once-obscure companies into multibillion listed companies,” he tells The Edge.
As their earnings grew manyfold and they became darlings of local institutional and foreign funds, semiconductor companies were accorded premium valuations that were way above established old-economy names in Malaysia.
In fact, Ng observes that these companies did not disappoint, as they continued to deliver earnings that beat expectations and showed growing positive cash flow while maintaining a healthy balance sheet. On average, the compound annual growth rate (CAGR) of some of the best names in the industry was more than 20% in the past decade.
“Although the share prices have corrected significantly in the past one year, such normalisation is expected, given that the stretched valuation exceeds the tolerable fundamental valuation. Even if we were to adopt the PEG (price-earnings-to-growth) ratio valuation method, at one point or another, these companies’ share prices were trading at valuations double or even triple their peak earnings annual growth rates,” he elaborates.
Ng views the normalisation of share prices as a positive, considering the market has its own cycle regardless of the sector. By allowing share prices to cool from their toppish valuations, he believes that, in the long run, the sector will trade at a more “palatable” level.
“At current levels, I do not believe it is the bottom yet because the variety of factors affecting the outlook is not going to go away in the immediate three to six months. Having said that, unlike some of the bears, I believe the semiconductor sector has a strategic importance that is irreplaceable, owing to its contribution to the ascent of technological advancement of nations,” he stresses.
Fortress Capital Asset Management (M) Sdn Bhd investment director Chua Zhu Lian is even more confident, as he predicts that the best is yet to come for Malaysian tech stocks. He remains optimistic on the industry’s prospects, given the rapid digital adoptions that have also been further accelerated by the pandemic.
He says his positive outlook is supported by trends in the age of “explosive digitalisation”, including the fifth generation (5G) network, the Internet of Things (IoT), artificial intelligence (AI), cloud computing, blockchain and electric vehicles (EVs). “The demand for chips and semiconductors will continue to grow exponentially as Earth gets populated by more and more sensors, and because of the need for automation to push for productivity enhancements, given the rising cost of labour, as well as the need for data privacy and encryption.”
Chua agrees that Malaysia will be a stand-out in the region, benefiting from the spill-over effects of US-China tensions, as industries shift from China and the US into Southeast Asia.
He observes that Malaysia has always been one of the preferred nations for semiconductor, telecommunications and technology, owing to its favourable ecosystem, which includes talent, industrial infrastructure and competitive electricity rates.
“The weak ringgit has also made Malaysia very competitive in terms of exports and relatively cheap for global MNCs (multinational corporations) to set up operations,” he says.
Nevertheless, Chua points out that it is also important to understand that the weak macro sentiment — caused by fears of recession, accelerating inflation, rising interest rates and geopolitical conflicts — have played a significant role in weakening tech demand.
“The weak sentiment affects the whole market, and the semiconductor sector is hardly a safe haven amid general market weaknesses,” he acknowledges.
After the surge in demand for OSAT services and semiconductor equipment over the past two years, Mercury Securities analyst Ronnie Tan thinks the industry is undergoing inventory adjustment.
“This adjustment is due to various concerns in the world such as rising interest rates and high inflation, which affects consumer purchasing power — more obvious in the smartphones and computer segment, as 3Q2022 global smartphone shipments fell 9.7% to 302 million units, according to IDC (International Data Corp) data. The industry will need more time to digest the current inventory level,” Tan says.
Time to buy? Or perhaps not
Looking at historical price-earnings ratios (PERs), semiconductor stocks are now trading much lower than they were during their peak of the past two years. Still, their valuations may not be deemed cheap compared to other sectors.
As such, do tech counters have more room to fall, given how overstretched their valuations were? Or are they relatively cheaper now and, therefore, ripe for the picking amid the pullback?
Tradeview’s Ng insists that the fall of tech stocks has been a healthy correction.
“A stock cannot be consistently trading at 80 to 100 times forward earnings, even if the growth rate is more than 20%, especially during a time when risk-free rates are rising exponentially,” he warns.
He acknowledges that high-growth stocks have always been attractive in a low interest rate environment because the cost of capital is cheap. But when the cost of capital is no longer cheap, the opportunity cost will be compared and weighted.
With slowing growth on the economic front due to tightening monetary policy and inflationary pressures in the background, high-growth sectors such as technology — and by extension semiconductor companies — face the biggest hit as funds continue to flow out towards risk-free asset classes, Ng explains.
He says: “Funds have more choices now, be it low-risk higher-yield bonds, fixed deposits, dividend-yielding equities or even plain-vanilla money market instruments.”
While share prices of local tech companies may have corrected by more than 40% to 50%, he believes investors still have plenty of other options.
“I do not think the worst is here, as the outlook remains bleak for the next three to six months at least. Given such circumstances, investors who favour this sector can still opt to nibble at tranches but not bite at this level yet. On a personal level, I wouldn’t as well,” Ng advises.
Mercury’s Tan agrees that Malaysia’s semiconductor and tech valuations are “very high” compared with peers in other countries.
“If you compare with the recent three to five years’ average PER, their valuation is currently still fine. If you compare with earlier years, their PERs are still rather high. Bear in mind that past interest rate hikes in some countries such as the US may compress the valuation of the semiconductor industry,” he says.
Be mindful of sideways movement
Fortress’ Chua believes tech counters should continue to remain in the portfolio of investors who believe in the trends of digitalisation. Risks to take note of, however, would be a severe market correction caused by anticipated factors, such as a recession or black swan events such as geopolitical conflicts.
“Investors putting in funds at this point of time need to ensure that they have the holding power, as well as the guts and appetite to ride through a downturn if it comes, so they may remain profitable through a recovery,” he suggests.
Mercury’s Tan concurs that there is a risk that sector valuations may still have room for correction, if the industry continues to come under pressure because of aforesaid concerns.
“While the semiconductor supporting services valuation remains quite high, there is light at the end of the tunnel for semiconductor segments, which continue to benefit from the structural shift, influenced by the mass adoption of EV, riding global automotive electrification,” he says.
Tradeview’s Ng and his fund believe in a diversified and balanced portfolio, and totally ignoring the tech sector because of the headwinds is not wise.
“What I would suggest is tweaking the weightage of the stocks in the sector but not to avoid it entirely. The risk I foresee is a near-term downside but a longer-term sideways trend for the sector after a supercycle in the past two years. If investors are not careful, they may be looking at more than 12 months of sideways movement of these shares,” he says.
Ng adds that the problem of investing in high-growth stocks — not only tech companies — is the low yield and dividends paid to shareholders.
“This means opportunity cost to investors who may be able to get better returns elsewhere, either from dividend stocks or risk-free assets. One can be patient with a long-term horizon if one still receives some form of yield. Most would not be able to tolerate minimal to no income from their investments when the fixed deposit rates are moving to 3% to 4%,” he says.
No rush to jump into tech stocks as market sentiment returns
Wall Street staged a relief rally recently even as traders remained divided on the state of the global economy and inflation at a time when the US Federal Reserve made a fourth consecutive interest rate hike of 75 basis points to 3.75%-4%.
Over the past month, the US benchmark indices have risen, with the Dow Jones Industrial Average up 11% and the S&P 500 gaining 4%. The benchmark US 10-year Treasury bond yield inched up to 4.16%.
On the home front, the FBM KLCI had risen 4.3% over the past month to close at 1,446.19 points last Wednesday, driven by telecommunication and plantation stocks.
Rakuten Trade Research reckons that the local bourse will maintain its rebound following a selldown at end-October and thus, it expects the benchmark index to trend between 1,440 and 1,455 points. In a Nov 7 report, it said buying activity may return to technology stocks and should continue in banking counters as well.
While overall market sentiment remains cautious, earnings of Bursa Malaysia-listed semiconductor-related companies have stayed fairly strong. Despite rising concerns about a supply glut, the likes of Unisem (M) Bhd, ViTrox Corp Bhd, Malaysian Pacific Industries Bhd and Pentamaster Corp Bhd continued to report healthy profit growth in their latest quarterly results, as these export-oriented tech firms ride the wave of the stronger US dollar.
But the fact remains that the valuations of local semiconductor-related firms are still relatively higher than those of companies from other sectors. Bear in mind that chipmakers are bracing themselves for a possible “worst downturn in 10 years”.
“We continue to believe we are entering the worst semiconductor downturn in at least a decade, and possibly since 2001, given the expectation of a recession and inventory build,” Christopher Danely, a Citigroup Inc semiconductor analyst, reportedly warned in August.
If tech stocks are still a wait and see, which counters are safe for investors to buy right now? After all, certain quarters are optimistic that the local market sentiment should improve when the political uncertainty is removed after the 15th general election (GE15).
It has not gone unnoticed that glove stocks are back on investors’ radar screens as a rotational play. Some market experts are also recommending banking stocks, given the rising interest rate environment.
In addition to having tech stocks as part of one’s investment portfolio, Fortress Capital Asset Management (M) Sdn Bhd investment director Chua Zhu Lian opines that investors should also consider dividend-driven sectors such as real estate investment trusts (REITs) with exposure to retail malls to ride the recovery of consumer spending post-Covid-19. “Investors may also consider industrial stocks with stable earnings and dividend payouts over the last 10 years as a good addition to their portfolio,” he tells The Edge.
Chua notes that foreign equities can be a good addition to investors’ portfolio, especially for those who are more enterprising and willing to learn the foreign investment process and how to manage fluctuation risks in foreign currencies.
Mercury Securities analyst Ronnie Tan believes the electronics manufacturing services (EMS) sector still has room to grow, especially for fundamentally strong companies such as Aurelius Technologies Bhd. He points out that Aurelius, a one-stop integrated EMS provider, is capable of offering end-to-end solutions, from concept to high-volume board assembly and finished products.
“With the automation of its production lines for its EMS business operations, this will increase its productivity and allow better control of its labour cost going forward,” says Tan.
Tradeview Capital Sdn Bhd CEO Ng Zhu Hann concedes that banking stocks are generally safer in a rising interest rate environment, largely due to the higher net interest margins, especially if the bank has a large portion of lending on the floating rate. However, he notes that these stocks have already rallied quite a bit in the past 12 months, although they are not back to pre-Covid-19 levels yet.
“This is probably due to fear of slower loan growth or weaker demand should the economy face some headwinds due to the global environment in 2023,” he says.
Ng observes that glove stocks, which were once market darlings, are at the bottom cycle of the sector now. “[The glove counters] will likely see another two or three quarters of sideways performance as global distributors and clients run through their inventories, which they front-loaded at the height of the pandemic,” he says.
Ng also draws some similarities between the tech and glove sectors when comparing the super cycle that both industries went through in the past two years. “We have been looking at companies that increased the price of their goods over the past year to pass on the rising cost of raw materials to end-consumers, as they may now enjoy net margin expansion with prices of raw materials, especially those tied to commodities, normalising,” he points out.
Ng says it would be ideal if these companies also export their products, which leads to an increase in foreign exchange earnings. A good example would be those that deal in consumer discretionary goods such as confectionery, biscuits, snacks and drinks, or fast-moving consumer goods (FMCG) companies, which are likely the key beneficiaries. “After all, once these companies increase prices, it is unlikely for them to adjust their prices downwards,” he adds.
Tradeview Capital is also positive on tourism-related sectors. “With the reopening of borders [since April], these companies will see demand normalisation. Good examples would be sectors such as breweries, hotel REITs and theme parks from 2023 onwards,” says Ng.
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